Tuesday, September 30, 2008

The payback for short termism

As the last of the building-society-turned-banks loses its independence it seems only right to ask whether the policy of demutualisation pursued by the Conservatives when last in office was anything more than an expensive failure. It is certainly interesting to note the symmetry between that policy an the other great Conservative housing policy- "the right to buy", i.e. that those living in Council owned social housing could buy their homes at a big discount. Indeed it is pretty clear that this policy lies at the root of the British obsession with property. The move from right-to-buy to buy-to-let seems almost inevitable given the way in which the banking system of the UK was deregulated.

It was a classic case of short-termism. The prices that Council tenants paid did not reflect the sunk costs that the state had put into the social housing in the Post Second World War period and the prices were therefore highly attractive- the incentive to buy was substantial. Likewise in the process of demutualisation of the building societies, the prospect of large profits from the launch of these new banks onto the stock exchange proved too much for the deposit holders. Meanwhile, the managements of these new banks, rooted in the housing market, offered greater competition for housing based lending products. The was a significant contributor to the house price bubble, as well as helping to create a culture of property ownership not dissimilar to the share price bubble of the 1920s. In the same way as a stock tip from a shoe-shine boy persuaded Joe Kennedy to exit the stock exchange in 1929, the endless TV shows promising profits from property should have told us what we needed to know about the market: that it was way over heated.

Now the party is over. There is little or no social housing available in most parts of the country and the available private rented sector is not tightly regulated. Insecurity of tenure and rapidly escalating rents seem set to create a major problem of homelessness once again- a problem that had seemed to have become a marginal question in recent years. The regulation of the housing market, before the 1979-97 government, may have gone too far in favour of the tenants, but we must remember that Rachmann was no isolated figure. The criminal actions of Nicholas Van Hoogstraten underline the ruthlessness that evil people are prepared to show- even without the pressures of a property crash.

I remain a believer in the rights of the individual. I do not want the state to take on direct roles in the free market, but to remain a referee and not a player. Nevertheless, in order to preserve liberty there must be a system of law and of justice. In the end, the market has punished those who lost sight of the long term. However, it was a failure of regulation to offer only short term benefits- both to ex-council tenants and to building society shareholders- that has helped to create the mess we are in. The crisis in Britain at least is rooted in a failure of regulation- in political short-termism. Therefore the price of this failure is the large bail-out that we have now seen.

In my view, the British banking system has now largely been secured. However the failure of the US to devote comparable resources to its own problems is now an existential crisis. A failure to secure the American banking system has global consequences- including in the UK.

The Bush administration must now truly go down in history as the most abject failure. Even if Hank Paulson can get a modified bill through the Congress on Thursday, it is quite clear that the Administration should stand down as soon as possible after the election. The crisis can not wait through the prolonged interregnum until January 20th.

The reckless and self serving choice by John MacCain of a wholly unqualified running mate now makes it highly likely that - as I have suggested previously- the next administration will be headed by President Barack Obama. It would be the final insult from the disastrous President Bush if he refuses to stand aside quickly on purely partisan grounds.

The Bush Bust stands as the legacy of this foolish, arrogant and incompetent President.

Meanwhile in Britain we can now only watch and wait and hope that the US Congress will address the crisis with an attitude of greater responsibility than it did yesterday.

Monday, September 29, 2008


Monday 29th September 2008 may go into history as the Black Monday of this swing of the economic cycle.
The failure of the US Congress to agree the bail out proposed by Treasury secretary Hank Paulson was quite clearly unexpected by the markets an the immediate and dramatic sell-off that followed was astonishing.
Britain and the US remain in the eye of the storm, yet the UK is following a consistent policy. The breakdown of the US political consensus leaves policy makers with no clear path as to what to do next.
Sterling has its worst day's trading in nearly fifty years.

Six banks have essentially gone under today: B&B in the UK, Glitnir in Iceland, Fortis in BeNeLux, Washington Mutual and Wachovia in the US, and Hypo Real in Germany.
As I write the NASDAQ is off nearly 10% and most global markets are off nearly as much.
This is now looking like a systemic breakdown.

Now I'm scared.

All is changed utterly

Firstly apologies for the lack of updates, the impact of the emerging crisis left me somewhat at the eye of the storm, and though there was much to write about, the speed and scale of the events left me too busy to comment. In addition I was scheduled to make a keynote speech at the Lithuanian economic forum, and this left even less time to devote to commentary.

This is not to say that there has been nothing to talk about.

The complete capitulation of the near century-old Wall St. investment bank model was more sudden and more complete than anyone could have expected- even those of us that have warned that the US had been playing with fire for some time are still staggered by the scale of the collapse.

The after shocks- including the forced consolidation of the British banking market and the growing problems in the European banking market are likely to continue for some time.

We still can not put a number on the scale of the problem. Sufficient to point out, perhaps, that the proposed Paulson bail out of $750 billion represents a number larger than all but about five of the the entire economies of the countries of the World.

It will be many years before the actual liabilities crystallise into the final bill, but it is quite clear that British, as well as American, tax payers will be bearing these new burdens for decades to come. The consequences for the Western economies are serious and will be long lasting.

Amidst all of the tumult, the rational voice of Vince Cable- the leader of the Liberal Democrat Treasury team- stood out. Having largely predicted the direction, if not the scale, of the crisis it was hard not to draw the contrast with the hapless Alastair Darling and the shrill posturing of the Conservative's George Osbourne. I am quite sure that there are many people, and not just amongst the Liberal Democrats, who fervently wish that Dr. Cable was in charge of the Exchequer!

Meanwhile, I will return to the coal face of trying to build an investment business in a world where so many revered institutions have ceased to exist in the forms in which we knew them, and that several centuries-old names have disappeared completely.

Tuesday, September 16, 2008

Boom and Bluster

As the impact of the financial storm in the US sinks in, there may be some surprising losers. Not so much the "masters of the Universe", since they know full well that with high rewards come high risks, but some who arrogantly believed themselves immune to the storms of the financial markets.

Six weeks ago, Russia was basking in the warm economic climes caused by a massive surge in the price of oil and other commodities. Though their balance sheet was relatively small, they believed that the biggest problem that they had to face was the inflationary risks of so much money coming into their economy. The liquid reserves would allow them to weather any storm.

Since then we have seen the BP TNK mess underline the real risks that even one of the largest and most powerful global corporations face when dealing with the crooked and opaque business world of the Silovik state. We have seen aggressive comments by Vladimir Putin about the running of Mechel undermine confidence still further.

Then came Georgia.

The contempt for international law and the extent of Russian aggression and the extremely intemperate language of the Siloviki was the political last straw for the international system. The US has now marked Russia ans a potential threat and will no longer deal with it except on those terms. The European Union, aware that the Russians are apt to use gas supply as a weapon has not put forward overt sanctions, but has also concluded that Putin is not a man that we could really do business with.

However, the economic impact of the Russian attack is now set to be felt in full.

The international markets, facing serious problems across the board is not willing even to look at Russia unless a major risk premium is applied. In some cases the markets will not supply capital at any price. The market for second-tier Russian banks is closed. This is a problem, since several of them are now urgently seeking capital. It seems likely that there will be Russian banks that will be caught up in the current financial crisis, and several secondary banks will not survive.

Meanwhile the price of oil has unexpectedly fallen very sharply, as I write, Brent Spot is down to $ 87. Though Russia is still making money at that level, the revenues to the Russian treasury will be sharply reduced, and as the global slow down continues, there seems little chance that the oil price can make a dramatic recovery.

Russia is politically isolated, but the market impact of Russian aggression is already much more serious. Already at least $8 billion of reserves have been needed to deal with the market volatility, and as further international investors try to get their money out of Russia the market rout grows ever deeper. The exchanges are down about 40% since the summer and the interbank markets are reaching levels not seen for four years.

There is a price for Russian risk, but, investors have concluded, it is not this price.

As Putin and Medvedev continue with another bout of willy waving: defiant in the face of near universal condemnation of their actions, they do not seem to notice that they are increasingly naked to the markets. At a time when there is a flight to quality, an unstable, corrupt, opaque and potentially hostile power is not the place that international investors want to be- and some of them will sell at any price, just to get out.

Though the Siloviks believe that their reserves can be used to insulate themselves from these problems, the fact is that they risk their credit rating if they do this. The blustering and arrogant Siloviki are caught between a rock and the hard markets. Politically the Siloviks may have got off lightly, but the markets seem set to punish the Russian regime to the maximum extent.

A secondary banking collapse in Russia might remind even the Siloviki that it is better to be polite, even to those you consider your enemies, because you might just need their help one day. In the end sending the Peter the Great to Venezuela will look like the act of hubris that it is- and the blustering of the Siloviks may diminish to the point where they have to face some hard realities.

Turmoil in New York may lead to real crisis in Moscow.

UPDATE: Trading in Moscow was suspended this afternoon after a further 18% fall.

Bournemouth days

The Liberal Democrats seem to be having a fairly harmonious conference. Alas, for the first time in several years, I will not be able to attend, since I have had to stay in Tallinn for the rest of the week.

It is particularly galling, since several of my friends who are somewhat irregular attenders will in fact be going.. ah well, there is always next year.

Monday, September 15, 2008

Creative Destruction

It has been one of the most dramatic weekends in finance that I can remember. The failure of Lehman Brothers and the shotgun marriage of Merill Lynch with Bank of America are seismic shifts in the world of money.

The fall of the House of Lehman ends a 158 year business overnight. Nearly 27,000 people- including several friends of mine- have lost their jobs. The merger of Merill could lead to even larger job cuts as the workforce of some 60,000 is slimmed down. It is hard not to feel sad when venerable institutions disappear.

Yet such is the nature of capitalism. I well remember at the time of the fall of Barings, walking past their offices- lights ablaze as the executives of the bank struggled with the developing crisis. In the end the losses of Barings- about £600 million look pretty minor compared with the scale of losses in the financial markets today. In those days my own office window overlooked the building that was being fitted out as new offices for Barings, and a poster was put up saying "Wanted: £600 million, can YOU help?" A certain gallows humour emerged across the City as it became clear what had actually taken place.

In the end, Barings fell to the control of ING and it continues as a business even today. In fact, the message of the fall of Barings is that markets, while they are intolerant of failure, are also quite resilient. The failure of the Lehman business model will ultimately free up people and capital for the market to apply in better ways. It also provides a warning that "moral hazard" continues to exist in the global market place- that neither the Fed nor the US Treasury can save market practitioners from themselves.

The next few hours, days and weeks will see a financial environment that is likely to be much changed in the light of the events of this weekend. However as it becomes clear that the business models of many financial houses were highly flawed, it also gives the chance for renewal. Businesses will change and adapt to new conditions and ultimately the adjustment should lead to greater efficiency based on a clearer understanding of risk.

The creative destruction of the free market will lead to renewal and change- as it is supposed to do. As I contemplate the loss of employment of so many talented people, and remember when I- at the merger of UBS and Warburgs- found myself in a somewhat similar position I begin to think that there is scope for cautious optimism, even after the titanic changes of the past few hours.

Saturday, September 13, 2008

What the F***?

After a phone call from the Russian Foreign Minister, Sergei Lavrov, to the British Foreign minister, David Milliband, that was reportedly a tirade of foul mouthed abuse, it still seems that Russia is not getting the message. The tasteless and wholly inaccurate comment from Dimitri Medvedev that "Georgia was Russia's 9/11" combines the usual sense of Russian arrogance and paranoid victimhood in one simple phrase.

Meanwhile Russian schoolchildren are being tought that Stalin was "a tough minded leader who took decisions in his country's best interest".

Actually, Mr. Putin, Stalin was a psychopathic murderer with the blood of millions on his hands, who entered into an alliance with Hitler that destroyed European peace. Almost entirely evil, by the end of his life he was essentially criminally insane.

I am back in Tallinn and the impact of the Georgian war is clear- the fear that Russia intends to destabilise Estonia and the other Baltic countries by picking further disputes and stirring up the local Russian population. In fact although I think that much effort in that direction is being considered by the Kremlin, I am also sure that the local Russian population are generally quite happy living in a wealthy and democratic state, where their rights are respected.

Several Russian speakers have said to me that although the extremists amongst both Estonian and Russian speakers make a lot of noise, the vast majority are building their lives regardless. There is greater recognition by Estonian speakers that Russian speakers need to be brought further in to the Estonian state. There is a determination that no further social fracture should develop. That the Kremlin will create as much trouble as they can is taken as a given. However the overall feeling is that Russia has committed a strategic blunder, firstly by their massive over reaction in Georgia and even more so by their hostile and aggressive response to the storm of criticism.

The recovery of the Dollar and the fall in oil prices last week, underlined the vulnerability of Russia, despite its offensive posturing. The joint exercises that the Russian navy is undertaking with the Venezuelan armed forces do not pose a substantive security threat to the United States, but the cold rage that Washington now feels about the erratic blustering of the Silovik state grows more obvious by the day.

Close to home, several senior Estonians are now pointing out the growing likelihood of the collapse of the Russian electricity grid if there is a hard winter this year. Doubtless the crooks in the Kremlin will regard their own folly as some evidence of an American plot.

In the well chosen words of the Foreign Minister of the Russian Federation: why don't you f****** sort out your own issues, you lousy f*****.

Friday, September 05, 2008

Who will bury who?

The Russian "August War" is still rumbling on, despite the fading of Western media interest. Russian troops continue to hold their positions well inside Georgia proper, and continue to harass Western deliveries of aid to shattered Georgia.

However already, the Kremlin is starting to have to pay the price for their aggression.

The FT reports this morning that the Central Bank of Russia has been forced to intervene to support the Rouble. The Bank confirms this, suggesting outflows of around $ 5 billion, however more independent voices suggest that he outflows over the month were more in the region of $15-$20 billion.

It is, of course, not just the impact of the war- significant though that has been. The threats by Mr. Putin against Mechel, the announcement that grain trading was to be considered a "strategic" sector, the continued attacks against BP-TNK all have unsettled the markets substantially.

Now, the perception has hardened that the risk profile of Russia needs to be significantly reviewed. The failure to enact a system based on the rule of law is undermining any attempt to attract vital international capital into Russian infrastructure. So, while Russia continues to hold significant international reserves, it will need to use them to ensure that the critical upgrading of electrical infrastructure, for example, is not so delayed as to force major power outages this Winter. It remains a race against time, and the state of the UES grid is now a considerable concern.

Russia is being repriced- the fall in commodity prices will reduce still further its attraction as an investment market- though at some point the markets should stabilise, the fact is that Kremlin contempt for law, both domestically and internationally, is already having a significant impact on Russia- and that impact is likely to grow stronger over the next few months.

The fat lady has yet to sing on the Georgian crisis.

Thursday, September 04, 2008

America's future

All things considered, the storm around the Republican Party's choice of VP nominee should have been highly predictable.

Let's face it, John McCain is 72. Were he to serve two full terms, he would leave office aged 81.

Eight Presidents of the United States, not quite 1 in 5, have died in office.

It may seem ghoulish, but the fact is that there is a significant chance that whoever John McCain might have chosen, they could indeed be called upon to serve as the leader of the United States were- God forbid- anything to happen to John McCain himself.

Of course, that also applies to Barack Obama, despite his being three decades younger than the Republican nominee. Although I do not particularly admire Senator Joe Biden, the fact is that in his thirty-five year service in the US Senate and in his own abortive runs for the Presidency, he has demonstrated his knowledge and indeed considerable influence in the American political system.

Sarah Palin has only been Governor of Alaska for three months less than two years, and Alaska has a population less than half of that of New Hampshire- or about the same size as Hamilton, Ontario. Her supposed executive experience leaves her totally ill equipped to assume office as the leader of the United States- and that is what we should be seriously considering as we weigh up the measure of the McCain-Palin ticket. I am on record as opposing the rise of a political class, and advocating breaking up this class. However Mrs. Palin is not outside politics- she is just from an exceptionally small an unimportant part of the American body politic. If we look beyond her political life, we do not find the kind of hinterland that could help to make her an informed and successful leader of her country.

Her education- a journalism degree completed at the University of Idaho- is little better than the much derided degrees in "media studies" in the UK, and makes a striking contrast with the institutions that the young Barack Obama attended- Columbia, Harvard Law School and the University of Chicago. Whatever the rights or wrongs of affirmative action, there can be no doubt that Sen. Obama has gained a first class education.

Beyond her education her sole hinterland is her family, which is why much attention is being paid to it though this, of course, comes before the National Enquirer turns its baleful eye upon the issue. Though I take my hat off to the Governor's eldest son for his decision to enlist in the American Army as a private, the fact is that- again- one gets the feeling that the Palin family does not respect the value of a good education. The latest imbroglio over the teenage pregnancy of the Governor's daughter reflects badly on a family that firmly espouses American Conservative principles. That the National Enquirer now alleges that Governor Palin has had an adulterous affair is beginning to make the Sarah Palin look like just as good material for Jerry Springer (who was Mayor of Cincinnati, a much larger city than Wasilla, Alaska), as the usual trailer-park trash.

All in all, the choice of Sarah Palin reflects very badly indeed on the judgement of Sen. McCain. That further problems seem set to emerge, I do not doubt.

They will be the fault of a man who chose misguided tokenism over common sense. John McCain knew that his VP choice would be carefully scrutinised. Instead of making a considered choice, it seems clear that he made a rushed, last minute decision. Through this choice, Sen McCain has demonstrated that his Republican colleagues were right to be fearful of his rashness and impulsive, maverick nature.

It should forfeit him the election.

Tuesday, September 02, 2008

Whom the Gods would destroy...

In the sunshine of the Croatian capital, my thoughts are drawn to the US Presidential race.

As the dust begins to settle on John McCain's choice of running mate, it is beginning to look an even more high risk bet than it initially appeared.

Mrs. Palin may be a full fledged member of the human race- teenage pregnancy and all- but her terrifying lack of experience and education makes Sen. McCain look frankly reckless.

All of the old fears about his maverick personality seem set to be concentrated on this extraordinary choice of running mate. Frankly it simply looks like tokenism of a very high order- but to make such a choice without having completed a full due dilligence is foolhardy in the extreme.

Sarah Palin may be the making or the breaking of the McCain Presidential bid- but if I was a Republican I would certainly be feeling very nervous.

If I was an American I would now regard Sen McCain as frankly too reckless to take the Oval office.